United States
Hong KongBusiness entities: liability, taxation and the trade-off between them
Sole proprietorships and partnerships pass income through with no liability protection. LLCs add liability protection with flexible tax treatment. S corporations pass through with payroll tax planning available. C corporations are taxed separately, producing double taxation on distributions.
Two questions decide entity choice: who is liable, and how is income taxed. Everything else follows.
| Entity | Liability | Taxation |
|---|---|---|
| Sole proprietorship | Unlimited personal | Pass-through on Schedule C; self-employment tax on all profit |
| General partnership | Unlimited personal, joint and several | Pass-through on Schedule K-1 |
| Limited partnership | General partner unlimited; limited partners limited | Pass-through |
| LLC | Limited | Default pass-through; may elect corporate treatment |
| S corporation | Limited | Pass-through; only salary is subject to payroll tax |
| C corporation | Limited | Taxed at entity level; dividends taxed again to shareholders |
The S corporation payroll question
The most examined point in this topic.
An S corporation owner-employee takes a salary, subject to payroll tax, and may take the remaining profit as a distribution not subject to it. That is a genuine saving relative to a sole proprietorship, where all profit is subject to self-employment tax.
The constraint is reasonable compensation. The salary must reflect the value of the services performed, and understating it to minimize payroll tax is a well-known audit target.
No more than 100 shareholders, only individuals and certain trusts and estates, no non-resident alien shareholders, and only one class of stock. Failing any of them terminates the election, and questions test the list.
Double taxation
A C corporation pays tax on its profits, and shareholders pay again on dividends. That is the classic objection.
It is less severe than it sounds where profits are retained and reinvested, or where the owner takes compensation which is deductible to the company. And C corporations offer fringe benefit treatment that pass-throughs do not.
The qualified business income deduction
A deduction of up to 20 per cent of qualified business income for owners of pass-through entities, subject to limits based on wages paid, property held, and the nature of the business.
Specified service businesses - including financial services - face a phase-out at higher incomes, which is a detail worth knowing because it applies to your own future practice.
The planning point for a financial planner
Entity choice interacts with retirement plan selection, insurance deductibility, buy-sell structure and estate valuation.
A question describing an entity change is rarely only a tax question, and reading it as one is how candidates miss the better answer.
Dollar limits and rate thresholds here are indexed annually and several were changed by the 2025 reconciliation act. Confirm the current figure against the IRS before relying on it.
Common questions
How are S corporations taxed?
Income passes through to shareholders. Only the owner-employee's salary is subject to payroll tax, with remaining profit distributed without it - subject to a reasonable compensation requirement.
What are the S corporation eligibility rules?
No more than 100 shareholders, only individuals and certain trusts and estates, no non-resident alien shareholders, and only one class of stock. Failing any terminates the election.
What is double taxation?
A C corporation pays tax on profits and shareholders pay again on dividends. It matters less where profits are retained or where the owner takes deductible compensation.
What is the qualified business income deduction?
A deduction of up to 20 per cent of qualified business income for pass-through owners, limited by wages paid and property held, and phased out for specified service businesses including financial services.
Does entity choice affect anything else?
Considerably. It interacts with retirement plan selection, insurance deductibility, buy-sell structure and estate valuation, so entity questions are rarely only about tax.